How Valid Are Lehman-Detroit Links?

As the concerns about the Big Three auto makers build, their fates have been linked to the collapse of Lehman Brothers in many ways. Some of those links are valid, but drawing the connection also might be a way for auto makers to invoke what has emerged as the great mistake of the financial crisis to bolster their case.

In an interview on the sidelines of the Journal’s CEO Council this week, Mike Jackson, the chief executive of the nation’s largest chain of auto dealers, put the blame for Detroit’s woes on the shoulders of Wall Street. “If Lehman Brothers hadn’t gone down and we didn’t have a credit panic, we would be muddling along,” the AutoNation CEO said. Jackson asserted that Detroit had started working to restructure when a cyclical downturn first hit the auto industry three years ago. He said that there were transformational changes made in areas such as labor contracts that got overshadowed by the financial crisis.

Some critics charge that while the credit crunch certainly exacerbated the U.S. auto industry’s problems, even the recent restructurings weren’t enough to bring back the sector. Joshua Rauh and Luigi Zingales of the University of Chicago Booth School of Business looked at General Motors specifically, writing “GM’s position on the verge of bankruptcy is not because of the severity of the current financial and economic crisis. The current crisis is simply the proverbial straw that breaks the camel’s back. Without the crisis, the camel would not have lasted long anyway.”

GM “burned through $9 billion of cash in the first 9 months of 2008. It has a labor cost 50% higher than U.S.-based Toyota plants, and it produces cars nobody wants. It is saddled with massive pension and healthcare obligations and it is essentially insolvent: its total liabilities are more than 50% greater than the book value of its assets,” Rauh and Zingales said.
They suggest that a Chapter 11 bankruptcy is the only solution for GM, although they say that it must be accomplished with the government’s help to avoid an inefficient liquidation.

AutoNation’s Jackson strongly disagrees. “Chapter 11 quickly turns into Chapter 7,” he said.
Once again he brought up the specter of Lehman Brothers. He used Lehman as an example of what happens when the government allows an important company to fail. “Letting Lehman Brothers go bankrupt has unleashed a global recession,” Jackson said. “And you can’t put Humpty Dumpty back together again.”

Critics say that Lehman’s failure can’t be compared to a collapse in the auto industry. The Economics And… blog writes that you can’t compare an industrial company to a financial firm. “The indirect impact of a major failure — by forcing creditors, and creditors of creditors, and so on, to deleverage themselves — is huge. And a loss of confidence in financial companies doesn’t just make it harder for them to find financing; it instigates a chain reaction of additional deleveraging on a grand scale. And as we have seen, this can make it impossible for many companies (and households) to find financing at all, and such tightening of credit can result in many more job losses than the collapse of a few large industrial companies.”

But Jackson defends the comparison, saying the chain reaction triggered by Lehman in the financial sector could easily be replicated in the industrial sector by a collapse of a U.S. auto maker. “You’re going to have an industrial meltdown that is equivalent to the financial meltdown because it’s not just the suppliers in the U.S. that are going to collapse. It’s the supplier base in Europe. It’s going to affect other manufacturers, plus the chaos that will be unleashed in the retail networks,” he said. “It’s like saying you’re going to deal with the fires in California by dropping gasoline on them. The U.S. economy is in deep trouble, and if you pick this moment to allow an industrial meltdown, you are unleashing unintended forces that you can’t stop once you’ve done it.” –Phil Izzo